Speech
Issues in Payments Systems

Thank you for the invitation to speak on the occasion of Australian Payments Clearing
Association's (APCA) Annual General Meeting. The Reserve Bank and APCA have
a long history of working constructively as they carry out their respective
responsibilities in Australia's payments system. We both have an interest
in ensuring a safe, efficient and competitive payments system that meets the
needs of end users.

When I last addressed an APCA gathering in May 2012, we were at a particularly interesting
juncture for the payments industry. The Bank was approaching the end of a two-year
period of public discussion and consultation about innovation in the payments
system. This extensive public process, involving all the key industry players
and users of the payments system had not been done before. After a roundtable
attended by most members of the Payments System Board, numerous meetings at
staff and management level, extensive feedback about published material and
so on, the Bank released the conclusions of its Strategic Review of Innovation
in the Payments System in June of that year. The Reserve Bank regards that
document, and the process that led up to it, as a landmark for the payments
system in Australia.

Interestingly enough, the Innovation Review was not mainly motivated by concerns,
on our part, that innovation was not occurring, even though it was sometimes
claimed that the regulatory regime inhibited it. On the contrary, we were seeing,
and continue to see, rapid innovation in some elements of the system, as financial
institutions, payment schemes and a variety of other players seek to deploy
new technology to compete with one another or to draw business away from traditional
payment forms like cash and cheques.

The most obvious recent example is the use of contactless payments. In mid 2012 relatively
few of us would have made a contactless payment. Now they have become second
nature to most of us and Australia has become the leading contactless market
in the world. While this does not represent a fundamental change in underlying
payment systems, it is a quite significant change in the way consumers interact
with the payments system and changes the cost of payments to both merchants
and consumers. Our recent diary survey suggests that the adoption of contactless
has largely reflected a switch from traditional contact-based card presentment,
but that there has also been some displacement of cash, particularly at smaller
transaction sizes.[1]

We are also now seeing the roll out by several players of mobile-phone-based point-of-sale
card acceptance facilities, where an intermediary provides a merchant some
form of attachment to a smartphone or tablet, turning that phone or tablet
into a card-acceptance device. This has significant potential to spread further
the appeal of electronic payments to smaller businesses.

At the same time, a clear trend towards online commerce and online banking is leading
to a rapid increase in remote – as opposed to point-of-sale – payments.
This is likely to be an area of increased competition, but is also the focus
of increased efforts to improve the security of payments. Overlaid on all this
is a proliferation of new models for using existing payment methods and indeed
some proposals to change fundamentally the way we think about payments.

The one area where there has been less progress than we might have expected in 2012
is ‘mobile wallets’ for point-of-sale payments, i.e. where a consumer's
card or account information is incorporated into a phone application and the
phone becomes the consumer's payment device. Of course, this may well change
quickly at some point.

So innovation is proceeding. It would seem premature to expect that we have seen
the apogee of technological development in the payments space. More likely
it will continue, in ways that are impossible to predict but are likely to
be ‘disruptive’ – the adjective of choice these days.

But there is a key caveat here. Innovation in the payments system is not just a matter
of technology – as remarkable as the extent of technological advance
has been. We have had rapid innovation in areas where individual entities can
innovate on their own, or where a central scheme has the capacity to push innovation
out to its members and/or users. These innovations can provide significant
benefits, but by themselves are not enough, in the Bank's view, to deliver
the policy goals set for the Payments System Board in its mandate. The setting
within which innovation occurs also matters. The Innovation Review recognised
that, in networks, where the ability of one institution to deliver value to
its customer is dependent upon how well it can connect with all the other institutions
and their customers, the full flowering of innovation depends to no small extent
on system architecture, as well as governance.

The technical architecture – for example, hub-and-spoke architecture versus
bilateral links – can make it easier for new or established players to
take advantage of technological change to bring new services to customers,
or harder. Governance around processes can be accommodating to change or resistant
to it.

Overall, the record in Australia in instances where innovation requires cooperation
between established players, especially where one or more of them feels the
need to protect an existing line of business, is mixed. We are all aware of
important cases where things have run into the sand.

This isn't just a problem for the industry. It's a problem for the users
of the system as well. Innovation in the ‘cooperative space’ –
where no single entity has control – is critical because it is this space
that determines the limits on the services that the rest of the payments system
can provide.

These issues have been a matter of concern for the Payments System Board for quite
a long time. The Board has always seen fostering innovation as part of its
‘efficiency’ mandate under the Payment Systems (Regulation) Act 1998. An important speech by
Philip Lowe as long ago as 2005 focused on payments system architecture (in
particular the bilateral nature of a number of important payment systems),
the limitations of governance arrangements and the challenges for the industry
in making cooperative investment decisions. His overall observation was that
the then-existing arrangements were hindering innovation.[2]

Of course the technical architecture of systems is largely a legacy of decisions
taken in an earlier era, probably for good reason at the time. Changing that
architecture is difficult and costly, though that is not a reason not to try,
and certainly not a reason not to adopt, better architecture for new systems.
The establishment of ePAL, for example, has provided an opportunity to improve
the network architecture of the eftpos system to allow it to better adapt to
the demands of the modern economy.

There have also been some important developments in industry governance. First, APCA
itself has this year implemented some significant reforms to its governance.
The new board structure includes representatives of the major banks, the mid-sized
and foreign banks and the credit unions and building societies. It also includes
an independent chair and two other independent directors. New types of players
are also represented at other levels within the APCA structure, better reflecting
the make-up of the modern payments system. APCA's willingness to make these
changes is to be commended.

Second, APCA and the Reserve Bank have also worked jointly towards the formation
of a new body that is intended to take a higher-level, more strategic view
of the payments system. This is a direct response to one of the important conclusions
of the Innovation Review – that some of the difficulties that institutions
faced in undertaking collaborative innovation might be alleviated by the creation
of a body that would have senior-level representation from a wider range of
organisations than have traditionally been members of APCA.

The resulting body is the Australian Payments Council. The Council, which will have
its first meeting next week, comprises 14 members, including from institutions
typically represented on APCA's Board, plus representatives of payment
schemes, retailers with their own payments infrastructure and other payment
services providers. The Council will have an independent chair and representatives
from APCA and the Reserve Bank.

The formation of the Council is a very important development. The Payments System
Board expects it to take an industry-wide view as to how the payments system
can better meet the needs of end users. On that basis, the Board looks forward
to active engagement with the Council.

That in no way indicates that we see a lesser role for APCA. On the contrary, APCA's
role continues to be very important, including in some aspects of self-regulation
and facilitating industry collaboration in determining rules and standards
for the five different clearing streams that APCA oversees. APCA has also been
active in thought leadership and advocacy for the payments industry. For example,
APCA is currently playing a role in thinking about transitioning payments to
the digital economy. It has published a series of ‘Milestones’
reports – the most recent in July – looking at developments in
the use of payments, and in particular the decline of cheques and the transition
away from cheques and cash towards electronic payments. Not surprisingly, the
reports highlight that use of electronic payments is continuing to grow strongly,
while use of the traditional paper-based payments is falling.

This, I might add, is consistent with the findings in the Bank's recent consumer
use survey. Our study – the third of its type – provides transaction-level
data from a survey of over 1,000 consumers. It found that cash remained the
most frequently used means of payment in 2013, though its use had declined
noticeably over the previous three years. Cash accounted for 47 per cent
of the number and 18 per cent of the value of all payments in 2013, down
from 62 per cent and 29 per cent respectively
in 2010. Cash was used particularly intensively for low-value transactions,
with consumers using cash for around two-thirds of payments under $20.

While the use of cash is declining relative to other payment mechanisms, it will
continue to have a role in the economy. Indeed, as the Bank has noted previously,
banknotes on issue have for a long period grown broadly in line with the nominal
growth in the overall economy. And the consumer use survey suggests the amount
of cash in respondents' wallets grew between 2010 and 2013. Together, this
evidence suggests that cash continues to have a significant role – not
just for small-value transactions, but also both as a store of value and for
precautionary use when other means of payment are not available. This is one
of the reasons that the Reserve Bank is undertaking its Next Generation Banknote
program, which will ensure that Australians can continue to have confidence
in the nation's banknotes as an effective means of payment and secure store
of wealth. But this is not inconsistent with the Bank's desire to encourage
the efficient use of electronic payments.

A more marked decline is evident in the use of cheques. The number of cheques written
in Australia peaked around 1995. Since then, the number of cheques written
each year per capita has fallen by more than 80 per cent (from 45 to 8). Over the same period, the number of
electronic payments per capita has risen by more than 400 per cent. As
the use of cheques has fallen, the per-cheque cost to financial institutions
and businesses has generally risen. The market has, and continues to, respond
to these pressures by looking for more efficient ways to process cheques, but
they are clearly the highest cost payment instrument, as will be confirmed
when the Bank releases its payments cost study later this year.

This decline in the use of cheques, a very expensive payment instrument, is one that
the private and public sector will have to manage. Part of that will involve
the introduction of effective and readily available substitutes for users,
and initiatives such as Superstream and eConveyancing are likely to be part
of this.

Central to the industry's efforts to develop new payment products and services
will be the New Payments Platform (NPP). I would like to use my remaining time
to make some comments about this important project.

A key point in the Innovation Review process was the industry roundtable held in
2012, focusing on the familiar themes of payments system gaps, governance and
architecture. My recollection of the discussion was that there was fairly widespread
acceptance that the industry would need to find a way to make some bold decisions
about cooperative investments in payments system infrastructure not too far
down the track. This has been echoed in subsequent views expressed by some
of the key players.

The Reserve Bank agreed. The Payments System Board has seen its own role as acting
as a catalyst for that cooperative investment. In the Conclusions to the Innovation
Review, the Board announced its intention periodically to set some strategic
objectives or general goals in terms of the services that the payments system
should be able to provide to end users.

The five strategic objectives that the Board set in 2012, after lengthy consultation
and with, I think it can be said, a wide consensus within the industry, were
as follows:

all direct entry payments to be settled on a ‘same day’ basis

the ability to make retail payments in real time

the ability to make and receive payments outside of normal banking hours

the ability for payments to carry more complete remittance information

the ability for payments to be addressed in a simpler way than using a BSB and account
number.

The first of these, the same-day settlement of direct entry payments, was achieved
in 2013. It is therefore now possible for recipient financial institutions
to make funds available to their customers sooner, without incurring credit
risk. The Bank worked closely with the industry to facilitate same-day settlement,
including the introduction of new liquidity arrangements for exchange settlement
accounts at the Reserve Bank.

These new liquidity arrangements will also be important as the industry moves to
meet the other four objectives from the Innovation Review. On those other objectives,
the Payments System Board set out a proposed time frame. It also offered one
piece of guidance, namely the suggestion that it would be desirable to have
all payments system participants connecting to a central hub or hub-like arrangement
in any new payments infrastructure, as opposed to continuing with the numerous
bilateral linkages that have proved to be not particularly conducive to either
innovation or competition. Beyond that, the Board did not seek to dictate particular
technical details of the solution, accepting that the industry itself should
provide the road map to the agreed destination.

One initial concern was that industry participants might respond with a number of
separate solutions, but no clear path forward. APCA has played a constructive
role in helping the industry to come together to form a project that will meet
these four strategic objectives. Initially, a small committee developed a proposal
for new payments infrastructure that is now being called the New Payments Platform.
After this proposal was welcomed by the Payments System Board in February 2013,
a broader group of 17 institutions came together to fund the initial development
of the project. The participating institutions have been going through the
final stages of vendor selection in the recent period. This has been an industry-driven
process, in pursuit of the goals articulated by the Board, and to which the
industry has committed.

We have detected considerable interest internationally in this approach – not
just the design features being proposed for the NPP, but also the way the central
bank and the payments industry are seeking to work collaboratively to achieve
major change.

This approach, however, is not without its challenges. It requires that industry
leadership and collaborative spirit be maintained over a sustained period.
At various key moments the project faces the risk of that spirit breaking down.

The Reserve Bank is fully aware of how complex and far reaching this project is,
and how costly. Our own contribution to the settlements architecture is a major
project for us as well. Having said that, let me also say, very clearly, how
important the Bank sees it that the industry deliver on its collective commitment
to deliver real-time, accessible payments to the community.

The Bank is also aware that there could be a temptation along the way to seek to
constrain the system, so as to conform to existing boundaries and business
models. This is where the broader governance arrangements now in place need
to take into account the interests of users and the need for the system to
be open to competition, not just the interests of the existing players.

We – the industry and the Reserve Bank itself – are building a piece
of national infrastructure. We should take every opportunity to increase its
potential value to the nation, rather than limiting it for fear of where it
might take us. The biggest risk with this project is probably not a technical
one. It is the risk that, in 10 or 15 years' time, we will look back and
see that we missed an important opportunity to provide something that will
fully and efficiently support the payments needs of our economy. We owe our
citizens a better outcome than that. We have to deliver, one way or another,
the architecture and products that they will need into the future.

It is not as though things are standing still in other jurisdictions. In the area
of real-time payments, we have seen major initiatives launched in Sweden and
Singapore – countries we would often view as comparators in terms of
their income levels and market structures. The Swedish system was launched
in December 2012 with a service known as Swish, which enables households to
send real-time payments via their mobile phones on a 24/7 basis, 365 days a
year. Singapore's system, known as FAST, was launched in March this year.
These two initiatives have wide participation, including by all the larger
banks in those countries and many of the smaller institutions. There are some
other countries, with lower income levels, lower penetration of electronic
payments and without universally ‘banked’ populations, that have
also made the leap to fast retail payments. These include Mexico with its SPEI
system, South Africa with Real-Time Clearing and India with its Immediate Payments
Service. Is there a plausible reason to accept Australia falling behind?

Delivering the NPP is also, in my opinion, in the interests of the Australian financial
institutions, which are at the heart of payments today. It can be expected
to lead to further growth in electronic payments and a reduction in costs.
It will maintain the ongoing relevance of the current players. If those players
do not provide Australian end users with the services they want, surely others
will seek to do so. Alternatively, the Reserve Bank would be duty bound to
consider a regulatory approach.

So our message to the industry is: stay the course. Continue the goodwill and prodigious
effort that has brought you to this point. Deliver on the commitments you have
collectively made. Let us together build a payments infrastructure that is
efficient, open to competition and that will support innovation into the future.

I thank APCA and its officers in particular for the efforts they have made, and continue
to make, in the NPP and across the payments landscape. And I wish the broader
payments industry success in its efforts to improve Australia's payments
system and look forward to ongoing cooperation between the Bank and the industry.